Earnings Tell The Story For Imdex Limited (ASX:IMD)

Imdex Limited's (ASX:IMD) price-to-earnings (or "P/E") ratio of 36.8x might make it look like a strong sell right now compared to the market in Australia, where around half of the companies have P/E ratios below 19x and even P/E's below 11x are quite common. However, the P/E might be quite high for a reason and it requires further investigation to determine if it's justified.

Imdex hasn't been tracking well recently as its declining earnings compare poorly to other companies, which have seen some growth on average. One possibility is that the P/E is high because investors think this poor earnings performance will turn the corner. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

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Does Growth Match The High P/E?

The only time you'd be truly comfortable seeing a P/E as steep as Imdex's is when the company's growth is on track to outshine the market decidedly.

If we review the last year of earnings, dishearteningly the company's profits fell to the tune of 20%. As a result, earnings from three years ago have also fallen 21% overall. Therefore, it's fair to say the earnings growth recently has been undesirable for the company.

Shifting to the future, estimates from the nine analysts covering the company suggest earnings should grow by 26% per annum over the next three years. Meanwhile, the rest of the market is forecast to only expand by 18% per year, which is noticeably less attractive.

In light of this, it's understandable that Imdex's P/E sits above the majority of other companies. It seems most investors are expecting this strong future growth and are willing to pay more for the stock.

What We Can Learn From Imdex's P/E?

We'd say the price-to-earnings ratio's power isn't primarily as a valuation instrument but rather to gauge current investor sentiment and future expectations.

We've established that Imdex maintains its high P/E on the strength of its forecast growth being higher than the wider market, as expected. At this stage investors feel the potential for a deterioration in earnings isn't great enough to justify a lower P/E ratio. Unless these conditions change, they will continue to provide strong support to the share price.

A lot of potential risks can sit within a company's balance sheet. Our free balance sheet analysis for Imdex with six simple checks will allow you to discover any risks that could be an issue.

You might be able to find a better investment than Imdex. If you want a selection of possible candidates, check out this free list of interesting companies that trade on a low P/E (but have proven they can grow earnings).

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.